Liquidity risk and financial stability of Malaysian Islamic banks

Abstract

This paper aims to examine the impact of Islamic banks’ liquidity risk on financial stability in Malaysia from 2011 to 2021. This study uses a fixed-effects model to estimate the impact of liquidity risk on the financial stability of 16 Islamic banks in Malaysia. Using bank-specific and macroeconomic data, the analysis considers two maturity-mismatch periods and the liquidity policy change, with robust analysis. The results expose the negative impacts of liquidity risk and impaired financing on financial stability. However, the findings highlight the significance of the liquidity policy coverage ratio and a stable economic environment for a stronger Islamic banking system. The findings stress the importance of policymakers continuously upholding their system’s resilience by enhancing the banks’ regulatory effectiveness and the country’s economic conditions. Islamic banks can improve their stability through effective liquidity management. This study provides new insights into liquidity risk, its impact on the financial stability of Malaysian Islamic banks and its implications for portfolio theory and Malaysia’s central bank liquidity risk policy document.